GAO-02-290R Earned Income Tax Credit Participation

United States General Accounting Office

Washington, DC 20548

December 14, 2001

The Honorable William J. Coyne

Ranking Minority Member

Subcommittee on Oversight

Committee on Ways and Means

House of Representatives

Subject: Earned Income Tax Credit Eligibility and Participation

Dear Mr. Coyne:

The Earned Income Tax Credit (EIC), which is expected to provide over $30 billion in

refundable credits in fiscal year 2002, is a major federal effort to assist the working

poor. The EIC is intended to offset the burden of the Social Security payroll tax on

low-income workers and to encourage low-income individuals to work. The amounts

of credit that taxpayers receive depend on the taxpayers’ incomes and the number of

qualifying children they have.1

 Taxpayers must file a tax return in order to claim the

credit. Prior evidence suggests that many eligible households have not received the

credit.2 You asked us to provide estimates of (1) the number of eligible households

and the number of those who did and did not participate in the EIC program and (2)

the amounts of credit foregone by nonparticipating households. You also asked that

we provide these estimates disaggregated by the number of qualifying children in the

households claiming the credit.

We used data from the Census Bureau’s Current Population Survey (CPS) for 1999 to

estimate the number of households eligible for the EIC. We obtained estimates from

the Internal Revenue Service (IRS) for the number of eligible taxpayers who claimed

the EIC for tax year 1999. Because the CPS and IRS data are based on samples, our

estimates are subject to sampling error. 3 In addition, the CPS database, while useful

for estimating EIC eligibility, do not contain all of the data needed to definitively

determine EIC eligibility. Our methodology and its limitations are described in

further detail in the enclosure. We sent a draft of this correspondence to IRS for

 1 A qualifying child must meet a relationship test (with respect to the taxpayer claiming the credit), an age test,

and a residence test. In tax year 2001 the maximum amount of credit that a taxpayer with no qualifying children

can earn is $364. The maximum for a taxpayer with 1 qualifying child is $2,428, and the maximum for a taxpayer

with 2 or more qualifying children is $4,008.

2

See, for example, John Karl Scholz, “The Earned Income Tax Credit: Participation, Compliance, and Antipoverty

Effectiveness,” National Tax Journal, Vol. 47, no. 1, (March 1994), pp. 63-87.

3 The sampling errors measure the extent to which samples of different sizes are likely to differ from the

populations that they represent. Each of the sample estimates in tables 1 and 2 is surrounded by a 95-percent

confidence interval indicating that we are 95-percent confident that the interval contains the actual population

value. In the tables, the upper and lower limits of the intervals are indicated by the value added to and subtracted

from the estimate.
GAO-02-290R Earned Income Tax Credit Participation

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review and comment. Their comments and our response are summarized at the end

of this letter. We did our work between February and December 2001 in accordance

with generally accepted government auditing standards.

Results

Table 1 shows the number of eligible households4, the number of those households

that did and did not participate in the EIC program, and the participation rate. Of the

total of 17.2 million households that were eligible for the credit, about 12.9 million

claimed the credit, representing a participation rate of about 75 percent. The

participation rate varied considerably by number of qualifying children in the

household. The participation rates for households with one and two qualifying

children were about 96 percent and 93 percent, respectively. In contrast, the

participation rate for households with three or more qualifying children was about

62.5 percent, and the rate for households with no qualifying children was only about

44.7 percent.

The data available did not enable us to determine the reasons for these differences.

The differences in participation rates may reflect actual behavioral differences across

the household types, but they may also reflect limitations in the data. Both

explanations are discussed in the enclosure. Given the possibility that limitations in

our data may explain some of the variation in participation rates by number of

qualifying children and the larger confidence intervals for these subgroups due to

their smaller sample size, we believe the estimates for the subgroups in tables 1 and 2

are less certain than the estimates for all households.

Table 1: Number of Eligible Households, by Participation Status and Number of

Qualifying Children, 1999a

Dollars in millions

Households

Total eligible Eligible

participants

Eligible

nonparticipants

Participation

rate

Total 17.2 + .4 12.9 + .4 4.3 + .5 75.0 + 2.7%

0 qualifying children 4.7 + .2 2.1 + .2 2.6 + .3 44.7 + 3.9

1 qualifying child 5.0 + .2 4.8 + .3 0.2 + .4 96.0 + 7.7

2 qualifying children 4.3 + .2 4.0 + .3 0.3 + .4 93.0 + 8.3

3 or more qualifying

children 3.2 + .2 2.0 + .2 1.2 + .3 62.5 + 8.3

a

The actual number of households in any of the subgroups presented in the table cannot be less than zero and the actual

participation rates cannot exceed 100 percent.

Sources: GAO’s analysis of data from the CPS and IRS.

In total, about 4.3 million eligible households did not claim the credit. Figure 1 shows

how these households were distributed by number of qualifying children. More than

half (about 60 percent) of the eligible nonparticipating households had no qualifying

children. Most of the remaining eligible nonparticipating households (about 28

 4

 In this letter, households are individuals or married couples. Eligibility is determined with respect to these

persons according to the income, residency, family relationship and other rules of the EIC.
GAO-02-290R Earned Income Tax Credit Participation

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percent of the total) had three or more qualifying children. Households with one or

two qualifying children accounted for only about 12 percent of the nonparticipants,

even though they represented about 54 percent of all eligible households.

Figure 1: Eligible Nonparticipating Households, by Number of Qualifying Children,

1999

Sources: GAO’s analysis of data from the CPS and IRS.

We estimate that in 1999 all qualifying households were eligible to claim a total of

$23.5 billion of EIC. IRS estimates that households that actually participated in the

program were eligible to claim $20.9 billion of EIC. This implies that nonparticipating

households did not receive about $2.7 billion of credits for which they were eligible.

The amount foregone by nonparticipating households represented about 11.1 percent

of the total credit that households were eligible to claim. Table 2 shows the amounts

of EIC that nonparticipating households within each of the qualifying child categories

were eligible to claim. The table compares these amounts to the total amounts of EIC

that all households within those categories were eligible to claim.
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Table 2: Amounts of EIC That Participating and Nonparticipating Households Were

Eligible to Claim, by Number of Qualifying Children, 1999a

Dollars in billions

Total amount that

households were

eligible to claim

Amount that

households who

participated were

eligible to claim

Amount that

households who

did not participate

were eligible to

claim

Amount that

nonparticipants were

eligible to claim as a

percent of the total

amount that

households were

eligible to claim

Total $23.5 + .5 $20.9 + .7 $2.7 + .7 11.1 + 3.5 %

0 qualifying

children

0.8 + .0 .4 + .0 0.4 + .0 50.0 + 4.1

1 qualifying child 7.2 + .2 7.1 + .3 0.1 + .3 1.4 + 4.8

2 qualifying

children

9.0 + .2 9.0 + .4 0.0 + .5 0.0 + 5.4

3 or more qualifying

children

6.5 + .2 4.3 + .3 2.2 + .4 33.8 + 5.0

a

The actual number of households in any of the subgroups presented in the table cannot be less than zero. The same is true

for the percentages in the last column. Numbers may not sum to totals due to rounding.

Sources: GAO’s analysis of data from the CPS and IRS.

Figure 2 shows that households with three or more qualifying children accounted for

the preponderance (about 81 percent) of the EIC that nonparticipating households

were eligible to claim. Nonparticipating households with no eligible children

accounted for most of the remainder (about 15 percent).

Figure 2: Distribution of EIC That Nonparticipating Households Were Eligible to

Claim, by Number of Qualifying Children in Household, 1999

Sources: GAO’s analysis of data from the CPS and IRS.
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Agency Comments and Our Evaluation

On December 12, 2001, we spoke with a representative of the Director of IRS’ Office

of Research who provided oral comments on our draft letter. The Director suggested

that we add a few more specific caveats to the ones that we already listed in our

methodology discussion regarding the use of CPS data to determine the number of

households eligible for the EITC. He also suggested that we describe in more detail

how we applied the eligibility rules to CPS data and that we clarify certain statements

made in the draft. We modified the correspondence as appropriate.

_ _ _ _

As arranged with your staff, unless you publicly announce its contents earlier, we

plan no further distribution of this report until 30 days after the date of this letter. At

that time, we will send copies to the Secretary of the Treasury, the Commissioner of

Internal Revenue, and the Chairmen and Ranking Minority Members of the Senate

Finance Committee and the House Ways and Means Committee, as well as the

Chairman of the latter Committee’s Oversight Subcommittee. The letter will also be

available on GAO’s home page at www.gao.gov.

If you have any questions, you may contact Jim Wozny or me at (202) 512-9110. Kevin

Daly, Wendy Ahmed, and MacDonald Phillips made key contributions to this letter.

Sincerely yours,

James R. White

Director, Tax Issues
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Enclosure

Methodology for Estimating Participation Rates for

the Earned Income Tax Credit

We estimated the number of eligible households (individuals and married couples)

using the eligibility rules under section 32 of the Internal Revenue Code and data

from the Census Bureau’s Current Population Survey (CPS). The CPS is a sample of

households with information about their income, age, marital status, number of

children, and other characteristics. We analyzed the data reported in the 2000 March

Supplement of CPS which contains this information for the preceding year. We

identified households in the CPS that met the eligibility rules under the Internal

Revenue Code, and, using the CPS sample weights, estimated the number of eligible

households in the U.S. population. We also estimated the amount of credit that these

households were eligible to claim.

We obtained estimates of the number of eligible claimants and the amount of credit

that they were eligible to claim from the Internal Revenue Service (IRS). These

estimates were based on a random sample of 1999 tax returns with the EIC claimed

on the return. IRS audited these returns to determine the accuracy of the EIC claim

and other tax return items, as part of their forthcoming tax-year 1999 EIC compliance

study. The estimates of eligible claimants are based on the number of returns where

the examiners did not reduce the EIC claim to zero. The estimates of the amounts of

credit are based on the amounts corrected by the examiners for overclaims or

underclaims on the returns. IRS conducted consistency and other tests on the data,

and the audits were subject to quality review.

Limitations of Our Analysis

The CPS does not contain all of the information needed to determine eligibility. Data

such as capital gains and contributions to individual retirement accounts are not

requested in the CPS survey. However, it is likely that the missing data have little

effect on our participation estimates. These types of income and deductions are not

common for the lower-income people who may be eligible for the credit. To verify

this, we examined the tax returns of households in the 1996 Statistics of Income

Public Use File, the most recent data available. We found that no more than 3

percent of households that met the other income limits for credit eligibility had these

types of income and deductions.

The CPS also does not have complete information for determining whether a child is

resident long enough in a household to be a “qualifying child” for the purpose of

determining the amount of credit that the households are eligible to claim. Children

must reside in the household for more than half the year (a full year for foster

children) in order to be qualifying children. The CPS survey asks only whether the

child is resident in the household during the week in which the survey is conducted.

This limitation in the CPS data means that some children reported in the survey may

not meet the residency requirement while others who meet the requirement may not
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be reported. To test the likely impact of this limitation, we checked the low-income

households that were surveyed in both the 1999 and 2000 March Supplements of the

CPS. We found that 97 percent of the children who were living in these households in

2000 were also living in the same household in 1999.

The CPS contains self-reported data from the survey respondents. Some analysts

have raised concerns that this information may not be reported accurately. A

National Research Council study that reviewed studies of the accuracy of the survey

data concluded that wage and salary information appears to be fairly accurately

reported in the CPS. The study also concluded that other types of income, such as

interest and dividends, may be underreported but that this underreporting is probably

not critical for studies of low-income people for whom these are not important

sources of income. The study did not review the accuracy of other household

characteristics relevant to credit eligibility that are reported in the CPS. Another

limitation of the CPS data is the possible underreporting of certain populations such

as the homeless.

As we noted in the letter, differences in the participation rates across household

types may reflect actual taxpayer behavior. The lower participation rate for

households with three or more children may indicate that taxpayers in those

households may be more likely to be married and filing jointly which is a filing status

with a higher income threshold for the requirement to file a tax return. Therefore,

fewer of these households may be required to file tax returns than households that

have similar incomes but fewer children. A household that is required to file a tax

return may be more likely to claim the EIC than a household that otherwise would

not be required to file a return. The relatively low participation rate of households

with no children may be due to the fact that these households receive significantly

smaller benefits from the credit than do households with qualifying children. Or it

may result from the fact that there is a relatively narrow income range in which

taxpayers with no children are both above the filing threshold and below the income

cut-off for EIC eligibility.5

 Because we did not have CPS and IRS data for the same

households, we could not examine characteristics of the eligible households that

would enable us to test these and other factors that may affect participation.

However, it is also possible that the variation in participation rates could result from

limitations of the data we used. If, for example, low-income households with no

qualifying children inaccurately claimed one or two qualifying children and IRS did

not detect all such cases of this misreporting, then the number of no-children

households in IRS’ study would be undercounted, while the number of one- and twochildren households would be overcounted. An undercount of no-children

households would mean that our participation rate for that group is understated.

Conversely, an overcount of the other two groups would mean that our participation

rates for them are overstated.

 5

 In fact, none of the taxpayers who file joint returns and are eligible for the no-child EIC have incomes above the

filing threshold.
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The variation in participation rates across groups also could be inaccurate if IRS

auditors involved in the EIC compliance study spent less effort (or had more

difficulty) determining whether households had more than two qualifying children

than determining whether taxpayers had one or two qualifying children. The number

of children up to two has a significant effect on the amount of credit that all eligible

households are allowed to claim. The presence of a third eligible child is important

only if one of the first two children that a household identifies is determined to be

ineligible. Moreover, taxpayers are not asked to identify more than two qualified

children on schedule EIC when claiming the credit. If IRS counted some households

that have three or more qualifying children as two-child households, then our

estimate of the participation rate for households with three or more children would

be understated, and our estimated participation rate for two-child households would

be overstated. The data collection instrument for IRS’ study did call for auditors to

collect information on more than two qualified children.

At the time that we were issuing this letter the Treasury Inspector General for Tax

Administration (TIGTA) was about to issue a review of IRS’ 1997 and 1999 EIC

compliance studies. We read a draft of the TIGTA review and discussed it with

officials from TIGTA and IRS’ Office of Research, which had a leading role in the

compliance studies. The TIGTA review does not directly address IRS’ counts of the

number of eligible EIC participants. The review raises questions about potential

inaccuracies in IRS’ estimates of allowable credits for 1999, which we report in table

2. However, the review does not provide a basis for us to determine the extent, if

any, of actual inaccuracies. IRS strongly disagrees with TIGTA’s assessment and

believes that their compliance estimates are reasonably accurate. We did not verify

the accuracy of IRS’ study.

(440024)